Euro’s fate is now in Germany’s hands

Opinion: Euro zone bond-buying program takes a hit from German court

By

SatyajitDas

Reuters

SYDNEY (MarketWatch) — The German Constitutional Court’s ruling earlier this month on the legality of Europe’s bond-buying program will have a much bigger effect on the euro and the euro-zone crisis than is being assumed.

Announced in 2012, the OMT (“Outright Monetary Transactions”) allows the European Central Bank to make unlimited purchases of government bonds issued by euro-zone members under specified conditions, providing funding and lowering borrowing costs. In conjunction with the austerity plan to reduce budget deficits and public debt and the banking union, the OMT has underpinned the relative stability of European financial markets over the last 18 months.

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The Constitutional Court’s review was prompted by a petition filed by 37,000 Germans questioning the OMT’s legal status. Following several months of consideration and often-heated hearings, the court decided to refer the matter to the European Court of Justice (“ECJ”) in Luxembourg. The court ruling was by a majority. Six judges ruled in favor of the referral. Two others dissented on the grounds that the suit should be dismissed as being outside the court’s jurisdiction.

The German court did not rule directly on the OMT but instead requested that the ECJ clarify several issues: The legality of the conditions of the program; the absence of any limit on purchases; the ECB’s ability to selectively purchase bonds of only some members; the lack of consideration of the credit quality of the bonds; the ability to purchase in the primary market; the need to hold the bonds to maturity, and the interaction between the OMT and other ECB and European Union programs.

Yet the court also stated that the OMT may be incompatible with German law. It argued that the program exceeds the ECB’s limited monetary policy mandate, infringes upon member states, and also circumvents the prohibition of monetary financing of euro-zone members. The Court found that the program was an act of economic policy, beyond the powers of the ECB.

Moves and countermoves

The German court’s referral creates an intriguing set of potential outcomes.

If the European Court of Justice agrees with the German court that the program is illegal, then the ECB’s program cannot be implemented. Or the ECJ may agree with the German court that the program is not legal in its current form, leaving the way open for a compromise. This result would curtail the OMT program, including a limit on the quantity of bond purchases, disallowance of debt restructuring, and not interfering with market prices where possible.

And if the ECJ rules that the OMT is legal in its present form, then the program would theoretically be legal under European law but not in Germany. The Bundesbank, the German central bank, might not be able to participate.

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Satyajit Das

Here’s how an issue could arise: Potential users of the OMT have to apply for a conditional credit line from the European Stability Mechanism, which requires government approval. If the German government and parliaments approve the credit line, then a legal challenge is likely.

The Constitutional Court would probably declare the program illegal, based on its current position. But the court would be in violation of EU treaties if it does not accept the ECJ ruling, although it is unclear whether this would lead to initiation of treaty infringement proceedings against Germany.

This impasse would trigger a legal crisis, forcing either the Bundesbank from not participating in the OMT, withdrawing German support for various euro-zone rescue programs or, theoretically, forcing Germany to exit the euro.
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The court’s decision has a political dimension as well. European politicians, especially those favoring ECB intervention, and non-German central bankers both agree with the two dissenting judges that the authority for the OMT lies with parliament, government or the central banks. With the European Parliament elections slated for May 2014, the decision may strengthen the political position of euro-skeptics.

The Constitutional Court sees its decision as protecting democratic rights. It seeks to establish “legal boundaries” to the powers of the ECB mandate and “strengthen the guarantees provided by [the German] constitution.”

The court also is concerned about the secretive process underlying much of the ECB’s decision-making. The court sought information regarding the ECB’s OMT program but was rebuffed on the ground that such details are “classified.”

Financial markets have generally remained unmoved by the court’s ruling. In part, this reflects the view that the OMT has never been activated and may be no longer needed. But if Europe’s debt problems reemerge, then the German court’s decision may restrict the ability of the ECB to act.

Clearly, the debate about the scope of the ECB’s powers, which underpins the euro and the fate of many deeply indebted European countries, has not been settled. Blame the unstable confluence of politics, finance and law that lies at the heart of the euro-zone crisis.

Satyajit Das is a former banker and author of “Extreme Money” and “Traders, Guns & Money.”

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